3 Core Ways to Fix Social Security -- Which One Speaks to You?

Social Security is arguably the most important social program we have in America. It currently provides a monthly benefit check to 42 million retirees and close to 20 million additional people who are disabled, survivors of deceased workers, or tied in some way to a primary workers' earnings. In the case of retirees, three in five count on their monthly Social Security check for at least half of their income.

Social Security's foundation is buckling

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However, this financial foundation for seniors and many future generations of workers is beginning to crack and crumble. Baby boomers are leaving the workforce at a pace of more than 10,000 per day, pushing the worker-to-beneficiary ratio down, and folks who are retired are living longer than ever, meaning the system is strained by people receiving benefits for perhaps two decades or longer.

The result? According to the latest annual report from the Social Security Board of Trustees, the program is projected to burn through its approximately $3 trillion in asset reserves between 2022 and 2034. Between 2034 and 2091, a $12.5 trillion budgetary shortfall exists, based on the current payment schedule to beneficiaries. If Congress does nothing between now and 2034, an across-the-board cut in benefits of up to 23% may be needed to sustain Social Security through 2091, per the Trustees report.

It's no grandiose secret that Social Security is in trouble -- lawmakers have known for more than a decade. Nevertheless, this knowledge hasn't produced any major changes to Social Security in a long time.

So, what should be done to fix the program? Lawmakers essentially have three core fixes to choose from: raise additional revenue, cut benefits to reduce costs, or do both.

Raise additional revenue to support current payouts

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One way to keep benefit levels consistent with current payouts would be to raise additional revenue for Social Security. Of the $957.5 billion it collected last year, 87.3% of it came from payroll taxes, with the remainder derived from interest income on its asset reserves and the taxation of benefits. The easiest way to raise additional revenue would therefore be to tinker with the payroll tax.

The payroll tax is a 12.4% tax on earned income between $0.01 and $127,200 that all working Americans pay. The top-end figure of $127,200, known as the maximum taxable earnings cap, usually adjusts higher with the National Average Wage Index on an annual basis. But it does mean that, in 2017 at least, any earned income above and beyond $127,200 is free and clear of Social Security's payroll tax. About one out of 10 workers receives a free pass on a portion of their income each year.

It's also important to note that most workers don't pay the full 12.4% themselves. If you're employed by someone else, you're responsible for half (6.2%), with your employer picking up the tab for the other half.

The easiest way to generate more revenue, and the Democrats' solution of choice on Capitol Hill, would be to adjust the maximum taxable earnings cap higher. There are a few ways this could be done. Either a moratorium on the payroll tax could be granted between the current maximum taxable earnings cap and, say $250,000, a figure commonly tossed around by Democrats as a point where the payroll tax should kick in again, or in a more aggressive sense the cap could be eliminated in its entirety. Thus, payroll tax would be collected on earned income between $0.01 and $127,200, and once again on earned income above $250,000, or it would be collected on all earned income, period.

Proposals that involve eliminating the cap entirely have suggested that it would completely resolve Social Security's long-term (i.e., 75 year) cash shortfall. The only true hold-up is that the well-to-do who'd suddenly be paying more tax would get no additional payment out of Social Security once they retire, since the program has a monthly maximum payout at full retirement age of $2,687 a month. This maximum monthly payout is exactly why the maximum taxable earnings cap exists in the first place.

Cut benefits to reduce program expenditures

Another option available to lawmakers on Capitol Hill is to reduce the amount the program is paying out annually. Not too many folks like the idea of a cut in benefits, but it, too, would work to keep Social Security sustainable for many generations to come.

There are a lot of ways to cut Social Security's expenditures, and the public hates nearly every one of them. These include cutting benefits once 2034 rolls around, as described by the Trustees report, or cutting benefits right now. We could also see lawmakers freeze annual cost-of-living adjustments on the wealthy, or on everyone, in order to reduce costs. This would mean your payment would remain static and lose purchasing power at a steady pace over time.

But one expenditure reduction solution that does have a good amount of public support is the idea of raising the full retirement age. Your full retirement age, or FRA, is the age at which the Social Security Administration deems you eligible to receive 100% of your monthly benefit, and it's determined by your birth year. You can find your FRA by using this table from the Social Security Administration.

By 2022, those born in 1960 or later will see their FRA rise to 67 years. Lawmakers have proposed the idea of gradually increasing the FRA to 68, 69, or 70 years, which would account for increase longevity. The result is seniors would need to either wait longer to receive 100% of their benefit, or they'd need to be willing to accept a steeper reduction in benefits if they claim early, beginning at age 62. A core solution of Republicans in Washington, adjusting the FRA may be able to resolve the entirety of Social Security's long-term cash shortfall.

The downside of such a plan is that it penalizes those folks who have no choice but to claim benefits early. Seniors in poor health, as well as those who can't get a job and have no income, could be particularly hurt by such a move.

Do both

The other option is that Democrats and Republicans could work together on a bipartisan bill that includes additional tax revenue and a gradual increase to the full retirement age. Imagine that, bipartisan cooperation.

A bipartisan bill could take two routes on the revenue-generation front. First, it could focus on just the wealthy, as in the example above. The other option is that it may also involve an across-the-board gradual increase in the payroll tax rate that all workers pay. My personal suspicion is that the only way an adjustment to the maximum taxable earnings cap would have a shot of being supported by GOP lawmakers in Washington is if the overall payroll tax on all workers were to creep a bit higher, as well.

Likewise, Democrats are highly unlikely to support a large increase in the FRA. A gradual increase to, say, 68 years, might be something that GOP lawmakers would be able to get through Congress -- and it would certainly help address the longevity issue.

While a bipartisan bill would probably be the best fix of all in the views of this writer, it's also the unlikeliest given the partisanship that exists in Washington today. Additionally, with each party knowing that they have a plan that would eliminate the budgetary shortfall, there's little incentive to back down and give the other party's solution the time of day.

Essentially, we're at a stalemate, and the longer Congress waits to act, the more painful the result could be for working Americans and retirees.

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